Mergers, acquisitions, and divestitures can be warning signs

As a general rule of thumb, I never own a company that sells more that 10% of itself (e.g. spins off a division) or buys another company that is larger than 10% of the original company (e.g. they acquire a company as a new division or subsidiary). These extraordinary events can radically change a company and divert its attention. While many such events will result in a stronger company, you cannot be confident in the short term that your investment is safe. It is usually safer to invest your money and time elsewhere while the dust settles.

Small changes are common in most companies. These types of acquisitions are typically handled by mid-level employees in a small part of the company. I am not talking about the actual signing of the change as that almost always requires the CFO and CEO to sign those documents. However, mid-level managers typically handle the details of how the new business is going to be integrated or which individuals and buildings are going to be spun off. This causes very little disruption in the core business since most of the employees are not worried about how the event affects their lives.

Major acquisitions or divestments are a problem. They often cause conflicts throughout the organization. If people are concerned with the personal affects of the change, they won’t work hard that day/week/month. You have certainly seen this in your life – when a significant change happens it becomes all consuming. Even your personal acts such as buying a new car can be all consuming and can cause you to skip mowing the lawn that day or that weekend. The acquisition of a new subsidiary can be that unsettling for the organization – they can put off doing the ordinary things that made them excellent for a couple days.

The crucial question is how long should you wait.  I typically hold off for one or two quarters. This gives the employees a chance to wake up and get back to work. It allows most of the planning for the change to stop and execution to begin.

Even if I like the reason for the change, I wait to make sure that the managers don’t screw it up. Both Peter Lynch and Warren Buffett have been quoted as saying, “Buy into a business that’s doing so well an idiot could run it, because sooner or later, one will.” http://quoteinvestigator.com/2010/05/31/any-idiot-can-run/ When significant change occurs in a company, the idiots can seem to come out of the woodwork.

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